Prepared by the Australian Bureau of Statistics

 

Twenty-Ninth Meeting of the

IMF Committee on Balance of Payments Statistics

 

 

 

 

 

 

   

   

 

   

 

 

 

COMPILING DATA ON NATURAL HEDGING— AN AUSTRALIAN PERSPECTIVE

     

Washington D.C., USA

October 24–26, 2016

BOPCOM—16/07

2

Prepared by the Australian Bureau of Statistics

COMPILING NATURAL HEDGING

AN AUSTRALIAN PERSPECTIVE

COMPILING NATURAL HEDGING AN AUSTRALIAN PERSPECTIVE

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Contents Currency Hedging in Australia ............................................................................................................. 5

Natural Hedging .................................................................................................................................. 7

Matching ......................................................................................................................................... 7

Leading and lagging ......................................................................................................................... 7

Price correlation .............................................................................................................................. 8

Pooling ............................................................................................................................................ 8

Measuring Natural Hedging in the Survey of Foreign Currency Exposure ......................................... 8

Measuring Natural Hedging in the International Investment Position and Balance of Payments

publication .......................................................................................................................................... 9

Balance sheet exposure ................................................................................................................ 10

Investment income exposure ....................................................................................................... 11

Merchandise Trade exposure ....................................................................................................... 11

Conclusion ..................................................................................................................................... 11

Bibliography ...................................................................................................................................... 13

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Currency Hedging in Australia

The Australian dollar was floated in 1983 and since then the flexible exchange rate has allowed

monetary policy to operate effectively by fostering real economic adjustments, cushioning the

economy from external shocks and smoothing fluctuations in business cycles such as through the

Asian Financial Crisis and more recently the Global Financial Crisis.

Even with effective monetary policy for macroeconomic stabilisation, for firms with foreign currency

assets, liabilities or trade exposures, fluctuations in the exchange rate can lead to changes in the

Australian dollar value of their balance sheet positions and cash flows. Depending on the distribution

of these foreign currency exposures across the economy, there could be implications for financial

stability and the real economy.

It is therefore important to understand the extent to which Australia is open to risks associated with

its foreign currency exposures and the extent to which they are hedged.

Australia’s balance sheet exposure is in a net liability position with the rest of the world reflecting

ongoing capital inflows, and while the size of this liability might be of concern as it is a significant

proportion of GDP, Australia has consistently had a net foreign currency asset position as Australia’s

liabilities are denominated mostly in Australian Dollars (AUD).

Graph 1 – Australia’s foreign currency balance sheet exposure

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$ M

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Exposure of the balance sheet and foreign currency

Net Foreign Currency Exposure on Balance Sheet Net Balance Sheet Exposure

Net liability

Net asset

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A net foreign currency asset position means the depreciation of the AUD reduces the size of Australian

entities’ overall net foreign liability position by increasing the AUD value of foreign currency assets

relative to foreign currency liabilities (the converse is true for an appreciation).

In 2015 80% of Australia's imports of goods and services were invoiced in foreign currency and 70% of

Australia's exports of goods and services were invoiced in foreign currency. These highly exposed

foreign currency invoices for trade mean movements in exchange rates can affect trade associated

cash flow by altering the Australian dollar value of trade payments and receipts. For firms, a

depreciation of the AUD will tend to reduce profits for net importers, while supporting the profitability

of net exporters and vice versa for an appreciation, unless these exposed foreign currency exposures

are hedged.

Firms generally develop their hedging strategy to reduce or eliminate their ‘net’ foreign currency

exposure on their balance sheet, or resulting from trade activity. The use of hedging varies depending

on the core business of the firm and the nature of their risk associated with their foreign currency

exposures. However, normally it involves a creation of a natural hedge and or the use of some type

of formalised hedge, such as a financial derivative, to offset underlying foreign currency exposures.

This paper will focus on natural hedging and the measurement of the extent to which a firm’s balance

sheet positions and trade flows may be exposed to fluctuation in foreign currency, before the use of

financial derivatives.

Figure 1 broadly illustrates foreign currency denominated activities that could be undertaken by firms,

and the resulting balance sheet foreign exchange exposure and trade foreign exchange exposures

giving rise to a net exposure position after natural hedging.

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Figure 1

Natural Hedging

Natural hedging can be characterised as structuring core business activities of firms such that net

exposure to fluctuation in exchange rate is eliminated or reduced before entering into explicit

derivative contracts to further reduce foreign currency exposure risks. For large complex and diverse

firms it is often difficult to quantify their net exposure positions after natural hedging. Natural hedging

in a broad economic perspective is the net balance in both the balance sheet and trade foreign

exchange exposed positions, reflecting the economies exposures to foreign exchange risk before the

use of formalised hedging instruments.

Matching

Firms involved in international trade often attempt to ‘match’ the currency denomination of their

receipts and payments in order to limit foreign exchange exposure by netting out their receipts of

foreign exchange from trade with their payments of foreign exchange from trade.

In firms where the balance sheet is highly exposed to foreign currency assets or liabilities a similar

match (or ‘money market hedge’) is often attempted. For example, a firm could borrow in domestic

currency, exchange this amount in the spot market for foreign currency, and invest in a secure offshore

asset with an income stream, offsetting some of its foreign currency liability position. The firm can

also use the earnings from the investment to service the debt, limiting the flow exposure.

Leading and lagging

Large diversified firms often use ‘leading and lagging’ which involves a parent company bringing

forward or delaying payments or receipts of foreign currency with its subsidiaries to offset the

COMPILING NATURAL HEDGING AN AUSTRALIAN PERSPECTIVE

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currency risks associated with other foreign currency transactions to manage cash flows across the

consolidated group.

Price correlation

For some firms a degree of natural hedge can be achieved through the correlation between the price

of the goods they produce and the exchange rate. For example, for an Australian gold producer selling

bullion into world markets in US dollars, an appreciation of the AUD would lower its receipts. However,

as an appreciation of the AUD is often correlated with iron ore prices, it is likely that rising prices would

provide some dampening of the impact of this exposure.

Pooling

In managing foreign exchange risks, firms may also be able to avoid engaging in explicit hedges if they

have sufficient currency diversification across their costs and revenues, or assets and liabilities.

Diversification should act to reduce aggregate currency exposure, at least to a level below the sum of

all individual currency exposures. This technique is often referred to as ‘pooling’ and is adopted by

some of the larger Australian resource companies.

Measuring Natural Hedging in the Survey of Foreign Currency Exposure

In light of the significance of foreign currency exposures, the Reserve Bank of Australia has

commissioned the Australian Bureau of Statistics to undertake a survey of firms’ foreign currency

exposures and their use of foreign currency derivatives to hedge these exposures. The survey has

been conducted every four years since 2001 with the most recent survey of Foreign Currency Exposure

(SFCE) conducted as at the end of March 2013 and the next SFCE to be conducted as at the end of

March 2017. Results are published in the Foreign Currency Exposure, Australia (cat no 5308.0)

publication and by the Reserve Bank of Australia in the Bulletin (most recently, December quarter

2013).

The aim of the SFCE is to capture quantitative and qualitative data about Australian enterprises'

foreign currency exposure and the risk management practices associated with that exposure.

The SFCE approaches 1100 resident entities which had significant foreign currency exposure in

assets/liabilities and/or exports/imports denominated in foreign currencies. The frame for the survey

is constructed from data supplied in the Survey of International Investment, the Survey of

International Trade in Services and from Merchandise Trade imports and exports records.

To this end, data is requested about resident-to-resident and non-resident-to-resident transactions

in:

Foreign-currency denominated equity assets;

Foreign-currency denominated debt assets;

Foreign-currency denominated debt liabilities; and

Foreign-currency denominated expected receipts and payments from trade in goods and

services.

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For the first time, the 2017 iteration of the SFCE supplementary survey will ask respondents to directly

disclose their use of natural hedging to eliminate or reduce their foreign currency exposure risks. Data

collected from the SFCE will allow for the accurate determination of Australian corporations naturally

hedged positions and net foreign currency exposure before the use of formalised hedges.

Figure 2 provides an example of the question to be used to capture the new data on natural hedging.

Figure 2 – Proposed Question 9 from the 2017 Survey of Foreign Currency Exposure

A challenging aspect to direct collection of natural hedging information from firms is that information

may not be readily separable or identifiable from normal business operations. The ABS therefore

expects to undertake an education process with data providers to mitigate any potential issues arising

from the identification of natural hedging practices within firms.

Measuring Natural Hedging in the International Investment Position and Balance of

Payments publication

As part of the December 2015 issue of the Balance of Payments and International Investment Position

(cat. no. 5302.0) publication, the ABS produced an article ‘A view into United States dollar exposure’

attempting to measure foreign currency exposure to the United States dollar (USD) before the use of

formalised hedging. The article drew on Balance of Payments and International Investment Position

data to calculate Australian resident exposures with the USD on the balance sheet (equity investments

and net debt obligations), income and trade, and provided a view of its exposure across broad

investment and trade activity. The article drew new links between Australia’s current account

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transactions in and out of the USD to measure Australia’s current account exposure between the USD

after natural hedging but before any formalised hedging.

Table 1 – USD currency exposure

2009 2010 2011 2012 2013 2014 2015

$m $m $m $m $m $m $m

Foreign equity assets in USA -209,864 -211,580 -211,736 -239,615 -301,988 -347,584 -342,495

Foreign equity assets in USD dollarised states

(b) -6,452 -7,554 -8,136 -9,110 -9,559 -11,659 -10,205

USD denominated Debt Assets -163,908 -220,450 -219,338 -194,618 -219,675 -292,974 -375,427

USD denominated Debt Liabilities 416,709 441,158 504,205 485,649 573,135 643,681 734,095

Net USD balance sheet exposure 36,484 1,574 64,994 42,307 41,914 -8,536 5,969

Income receipts on Australian Investment in

the USA 8,230 10,279 8,734 7,434 8,050 10,674 9,539

Income payments on USA investments in

Australia -15,767 -21,887 -19,853 -22,064 -22,860 -22,233 -22,478

Net USD denominated payments of

investment income (c) -7,537 -11,608 -11,118 -14,630 -14,810 -11,559 -12,939

USD invoiced receipts from trade 154,896 191,278 220,533 205,334 219,876 222,810 204,782

USD invoiced payments for trade -103,784 -111,545 -128,548 -135,413 -134,270 -144,450 -151,732

Net USD invoiced receipts from trade 51,112 79,734 91,985 69,921 85,606 78,360 53,050

Net USD current account foreign currency

exposure 43,575 68,126 80,867 55,291 70,796 66,801 40,111

a This table assumes that all equity assets are held in the USA and the stated dollarised states, and does not account for United States dollar denominated equity assets in other economies.

b Sovereign states which use the USD as primary currency are the British Virgin Islands, East Timor, Ecuador, El Salvador, Marshall Islands, Federated States of Micronesia, Palau, Panama and Turks and Caicos Islands.

c The ABS does not collect currency information for income on investments. A proxy based on country of counterpart domicility (in this case the USA) has been used as values for interest income.

Balance sheet exposure

Australia’s net USD balance sheet exposure was derived using data used to compile Australia’s

international investments position and identifying those asset holdings (both equity and debt) in USD

and liabilities (debt issuances) in USD from collected data. In economy wide terms the netting of these

position inherently accounts for natural hedging and is the net USD balance sheet exposure position.

This can be applied to all foreign currency denominated assets and liabilities to get a net balance sheet

foreign currency exposure position.

The net balance sheet exposure is the net of all the balance sheet positions and is calculated as:

Foreign Equity Assets plus Foreign Debt Assets less Foreign Debt Liabilities =

Net Foreign Currency Balance Sheet Exposure

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Australia’s net USD balance sheet exposure as at December 2015 was in a liability position of A$6.0

billion from an asset position of A$8.5 billion in the prior year.

Investment income exposure

Similar to receipts and payments from trade, a natural hedge can exist for receipts and payments of

investment income. Receipts and payments of investment income were collected on the Survey of

International Investment and used to compile the Balance of Payments and International Investment

Position. The ABS does not collect currency information for income on investments. A proxy based

on country of counterpart domicility (in this case the USA) has been used as values for interest

income.

The USD net foreign currency exposure on income from investments is calculated as:

Primary Income receipts in foreign currency less Primary Income payments in foreign

currency = Net Foreign Currency Income Exposure

As at December 2015 Australia’s net USD denominated receipts of investments income was in a net

deficit position of $12.9 billion.

Merchandise Trade exposure

USD Invoiced receipts and payments from trade were derived from International Merchandise Trade

Statistics (IMTS) which was collected from the Australian Customs and used to compile the Balance of

Payments and International Investment Position publication and the monthly International Trade in

Goods and Services (cat. no. 5368.0) publication. Netting of the USD invoiced receipts and payments

from trade, inherently accounts for natural hedging and is the net USD trade exposure position. This

can be applied to all foreign currency denominated trade receipts and payments to get a net trade

foreign currency exposure position.

The net trade exposure after natural hedging is calculated as:

Trade receipts invoiced in foreign currency less Trade payments invoiced in foreign

currency = Net Foreign Currency Trade Exposure

As at December 2015 Australia’s net USD invoiced receipts from trade was in a net surplus position

of $53.1 billion.

Australia’s Net Current Account exposure as at December 2015 was a surplus of $40.1 billion down

from a surplus of A$66.8 billion in the prior year.

Conclusion

The ABS has undertaken work to improve hedging data with the re-development of the SFCE to

explicitly question firms engaging in foreign dealings about their natural hedging activities. For

firms, there may be some difficulties in determining their exposure to foreign currency risks outside

of the use of formalised hedging instruments. As a result the ABS will be undertaking a respondent

education process to assist in identifying true exposures to foreign currency fluctuations after

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natural and formalised hedging. This paper also highlights that data used for the compilation of

Australian Balance of Payments and International Investment Position can also be used to compile a

net exposure position before formalised hedging.

Questions for the Committee:

1. Do Committee members have any suggestions for improvements to the framework

described for natural hedging (pages 7 – 8)?

2. Does Committee have any suggestions for improvements to the compilation and

presentation of data on natural hedging (pages 8 – 12)?

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Bibliography

Becker and Fabbro, Limiting Foreign Exchange Exposure through Hedging: The Australian Experience,

http://www.rba.gov.au/publications/rdp/2006/pdf/rdp2006-09.pdf, 2006-09.

ABS, Foreign Currency Exposure, Australia, March Quarter 2013 (Cat. No. 5308.0),

http://www.abs.gov.au/AUSSTATS/abs@.nsf/Lookup/5308.0Main+Features1March%20Quarter%20

2013?OpenDocument

ABS, A view into United States dollar exposure, Balance of Payments and International Investment

Position, Australia, (Cat. No. 5302.0),

http://www.abs.gov.au/ausstats/abs@.nsf/featurearticlesbytitle/340E1114F6183724CA257122001A

C421?OpenDocument

Rush, Sadeghian and Wright, Foreign Currency Exposure and Hedging in Australia,

http://www.rba.gov.au/publications/bulletin/2013/dec/pdf/bu-1213-6.pdf, 2013.

y